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Coping With the Aftershocks of a Sponsor's Default

THAT Friday night five years ago when a van rolled to the curb and half a dozen process servers bearing stacks of 200-page legal papers climbed out still grips the minds of people at the Acropolis, a 16-building co-op near the towers of the Triborough Bridge in Astoria, Queens.

Making their way home from work that crisp March evening, residents of the five-story walkups ringing a slim courtyard on Ditmars Boulevard had no notion that for years those legal papers would hang over their heads, their bank accounts and their sense of security.

The Bank of Tokyo, holder of the underlying $25.6-million mortgage on their 617-unit complex, had filed to foreclose -- without warning.

Robert Bass, president of the co-op board, remembers the night the van came, and the nights that followed. "They rang your bell, constantly coming back," Mr. Bass said. "They wanted to make sure they served everybody. My phone was ringing off the wall. People panicked. They thought they would lose their life savings, and be dispossessed on top of it."

There is no central registry for all the buildings -- and, more poignantly, all the people -- whose financial health was shaken when the bottom dropped out of parts of the co-op market after the boom of the 80's. It was a time when promises went unkept, renters balked at paying for neglected apartments and shareholders stopped paying maintenance; a time when sponsors defaulted and disappeared -- some after pocketing proceeds -- and when banks foreclosed and some buildings even deconverted, leaving residents owing loans and owning nothing.

Now, six years after cracks in the financial underpinnings of many co-op conversions first surfaced,"the vast majority of troubled co-ops have resolved their problems," said Gary Connor, chief of enforcement in the New York State Attorney General's real estate financing bureau. But the financial condition of many co-ops remains, at best, guarded, Mr. Connor said, and new cases regularly arise.

Great pains would be suffered before the Acropolis struggled back to its feet, and its workout would serve as a model for dozens of other troubled co-ops. But residents of 101 Lincoln Road, a 6-story building in the Flatbush section of Brooklyn, would never recover: Their co-op has deconverted to a rental building, and savings have been lost.

"In the end, I still owe $60,000 for nothing," said Martin McMichael, former president of the co-op board. "I don't have anything."

The Attorney General's office does not maintain records on the financial difficulties of co-ops. But between 1980 and 1994 in New York State, 11,688 buildings containing 830,833 apartments were either built as, or converted into, co-ops or condominiums.

"We have historically stated that about 10 percent of offering plans that came through from 1980 to the present have shown some type of sponsor-related financial problem or default," Mr. Connor said. That percentage holds true for the 1,850 members of the Council of New York Cooperatives, which only tracks information on its own members.

One of the hardest hit communities during the co-op market collapse was Queens, where Borough President Claire Shulman created a task force to help co-ops work their way out of trouble. Buildings containing about 80,000 apartments were converted in Queens, Mrs. Shulman said, "of which about 20,000 got into some kind of difficulty."

Although there have been few conversions in recent years (31 across the state in 1994 compared with 1,361 in 1987, the peak year), there has been a strengthening in the market for individual apartments -- mostly larger, more expensive units but, in recent months, trickling down to studio and one-bedroom sales, said Alan J. Rogers, managing director of Douglas Elliman, a major brokerage company in Manhattan.

The slight upturn notwithstanding, thousands of co-op owners -- unable to sell or even refinance their individual mortgages -- are still hoping to dig out of the financial hole while not quite comprehending how they got knocked over the edge.

What hit them was a one-two punch to a market that was already out of shape at the opening bell -- a market bloated by overvalued properties purchased with mortgages granted to speculating sponsors by high-risk-taking lenders. The big blows were the Tax Reform Act of 1986, which stifled incentives for outside investors to buy apartments, and the confidence-chilling stock market crash of 1987.

"Looking back," said Michael Finder, a lawyer who has represented numerous co-ops as they struggle for recovery, "it's amazing that everybody had such a myopic view of the economics of New York City in believing that the bubble would expand throughout all the boroughs. There was heavy speculation in neighborhoods where the economy could not possibly support the expectation of expanding gentrification."

There have been earlier co-op waves this century, but they were "user-initiated, rather than by sponsors," said Herbert Marcuse, an urban history professor at Columbia University.

IN the 20's and 30's, "there was a strong ideologically driven move toward cooperative living," the professor said, "and it succeeded. There were a number of buildings converted and others that were built in New York City." But even the best intentions could not survive the Great Depression.

After World War II, another series of co-op conversions and construction, including efforts to build single-family homes in groups, took hold, primarily by people seeking to hold down operating and construction costs.

The most recent co-op wave, Professor Marcuse said, "is a far cry from the original spirit of the cooperative movement, motivated by the financial consequences for the participants rather than any wish to live convivially or communally."

For many owners of rental buildings during the co-op wave of the 80's, the conversions represented a chance to realize the market value of individual apartments in buildings whose earning capacity had long been restricted by the rent-regulation system.

Conversion sponsors obtained bank financing and bought at prices based on the expectation of gradual sales of vacant apartments. But when the market collapsed, the sales never occurred, and the buildings were burdened with excessive debt, sometimes leading to default.

"It was horrendous because the conversions had less to do with the true value of buildings, but rather what the sponsor thought was the maximum value all the apartments could achieve on selling all the apartments," said Stuart Saft, chairman of the Council of New York Cooperatives.

Many sponsors, in their conversion plans, would add a wraparound mortgage to the underlying mortgage, creating additional capital for themselves and adding debt to the resident-shareholders who purchased the individual apartments. Tenants, sometimes, did not have the power to block the wraparound or, often, did not raise objections because they were more interested in buying apartments at low insider prices and then selling for a quick profit.

BEFORE 1986, a sponsor could expect to sell blocks of his unsold apartments to other investors -- a syndicate of doctors, for example -- who saw short-term tax benefits and long-term value in eventual sales to outsiders. But the 1986 Tax Reform Act eliminated most of those deductions, and, in time, a significant portion of the market.

The following a year, 1987, the stock market crashed, with the Dow Jones average dropping from 2,722 in August to 1,739 in October -- and by 508 points on Black Monday, Oct. 19, alone. "Wall Street, the banks, law firms began making a lot of layoffs," Mr. Finder said, "not just white-collar workers earning $200,000, but support staff, a lot of middle-class folks making $35,000. The ones who buy apartments in Queens."

Sponsors started applying for, and getting, end loans -- the mortgages for individual apartments -- against the value of their unsold apartments. Often, the sponsor got a loan based on an estimate of one-third of what the apartment's price would be when it was someday sold to an outsider, even though the apartment was still occupied by a rent-regulated tenant. The rent the sponsor received would be significantly less than the maintenance and debt service the sponsor had to pay.

"Each step the banks took was stranger than the last," Mr. Saft said. "They lent far more against the building than the building was worth and they lent far more against the apartment than the apartments were worth. All they saw was short-term dollars."

By 1989, because of the contraction in New York's economy, sales plummeted. Out of their pockets, sponsors had to pay the shortfall in maintenance on the apartments they held, and also the debt service on their end loans, and on the mortgages for the buildings themselves. They began to default.

It was on the evening of March 22, 1991, that the van from the Bank of Tokyo pulled up to the Acropolis in the heart of a thriving commercial district near the el in Astoria -- a complex built in 1927 on a foundation of bricks fashioned from the ballast of trading ships. "This place is what New York is all about," said Donald Novitt, the lawyer for the co-op corporation, "a regular United Nations, salt-of-the-earth working people."

A group headed by Marsar Realty was the sponsor at the time of conversion in August 1988. It looked like a good deal. "People lined up in the rain to purchase," Mr. Novitt said.

But "the co-op was doomed from the start," said Mr. Bass, the board president, "unless it could restructure the mortgage." The original loan was for $25.6 million. At the time of the final workout the property would be appraised at $12 million.

During the first year after conversion, Mr. Bass said, "many operating costs were absorbed by the sponsor" -- a tactic used to keep the initial maintenance low to attract buyers -- "and these hidden costs would come back to be billed to the shareholders."

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Hidden costs often constituted one of several time bombs written into offering plans that potential buyers either failed to notice or chose to ignore because they were more interested in low apartment prices than riskier elements in the conversion, according to real-estate lawyers.

In some cases, sponsors sold the apartments but retained building amenities, like the garage or the commercial space, siphoning off revenues that would have subsidized the property. Some plans included "dancing interest," adjustable mortgages with low start-up rates followed by walloping increases.

"In 1989," Mr. Bass said, "we woke up one morning and found ourselves with a $100 maintenance increase and the possibility of another $100 in six months."

Marsar had retained 65 percent of the units and, therefore, controlled the board, a common situation that often left resident shareholders cut off from vital information. "Too late," Mr. Bass said, "we started finding out that we were millions of dollars in arrears to the bank and to many vendors. He had stopped paying."

AFTER months of negotiations, a deal was struck in which the sponsor agreed to auction his units and relinquish control of the board. Meanwhile, negotiations to restructure the mortgage were under way with the bank.

The auction, held in October 1990, "did not go the way we hoped," Mr. Novitt said. "Over 400 units were sold, but 350 went to one individual, Daniel Weinberger, for $1 each, and those had rent-regulated tenants." For his first two months, Mr. Weinberger didn't pay maintenance, Mr. Novitt said, "and we sued him." Mr. Weinberger filed a countersuit. The Bank of Tokyo wanted out, and the van arrived.

The Acropolis had one distinct advantage -- political clout. City Council Speaker Peter F. Vallone, who represents Astoria, had once been the lawyer for the tenants' association. And Borough President Shulman was not sitting idly by while, she said, "we were getting frantic calls from young couples who had invested their last nickel in their first real estate deal."

And so a workout process began that has served as a model for dozens of co-ops. Mrs. Shulman and Mr. Vallone called a meeting and "told all the parties that there will be no talk of bankruptcy, that an amicable resolution had to be reached," Mr. Novitt said.

Thirty meetings and 20 months later, the workout was in place: For $100,000, Mr. Weinberger transferred his 350 units to a holding company formed by the Bank of Tokyo. The bank reduced the mortgage from $25.6 million to $17.6 million, leading to a 17 percent maintenance decrease. The bank benefited because its shortfall between maintenance and rents on the individual apartments it owned narrowed.

But in October 1994, there was a glitch. The bank tried to sell the mortgage, at a discount, to a private investor. The co-op balked, and Mrs. Shulman called another meeting at which, Mr. Novitt said, "Peter Vallone went ballistic on the Bank of Tokyo."

The parties appealed to the Community Preservation Corporation, a consortium of 57 banks and insurance companies that finances housing. "What we did, and it worked beautifully in this instance," said Michel D. Lappin, the corporation president, "is purchase the underlying debt at a price that eliminated any operating deficits from the management of the building so that even if there was never another unit sold it could still pay for its normal operations. Then we organized some of our member banks to do the end loans on new sales."

Since the Acropolis, Mr. Lappin said, that formula has been applied to about 5,000 units in 25 projects, with 21 more projects currently in the pipeline.

Under the final workout, with the property reappraised at $12 million, the underlying loan was reduced from $17.6 million to $9.5 million, with a mortgage granted by the Community Preservation Corporation paying off the bank. The bank was able to write off $14 million in losses.

With political figures urging it on, the State of New York Mortgage Agency agreed, in a record three months, to insure the underlying loan. And when the deal closed last April, all of the apartments were transferred to the co-op. "Now we were in control of our destiny," Mr. Bass said.

EIGHT apartments have been sold since. "Units that went for $1 at the auction are now selling for $25,000 to $40,000," Mr. Bass said. "For the first time ever, the co-op is operating in the black. And people are breathing easier."

There would be no such help for the people at 101 Lincoln Road in Flatbush.

The sponsor for the 82-unit building was Aaron Ziegelman, a converter who, by 1989, had taken over 140 buildings, including two around the block from 101 Lincoln Road.

The residents of 101 Lincoln were "West Indian, African, hard-working middle-class people," said Mr. McMichael, who became president of the board after Mr. Ziegelman defaulted. The building later deconverted with the Federal Deposit Insurance Corporation taking title.

"A lot of these people left, simply went back home," said Mr. McMichael, "because they figured, 'I'm not going to let the American government take what little I have left.' "To the underlying $1.45-million mortgage, granted by the Federal Home Loan Mortgage Corporation, or Freddy Mac, Mr. Ziegelman had added a $2 million wraparound. Twenty apartments were sold, three to insiders.

Mr. Ziegelman rehabilitated the sold apartments, but those occupied by rent-regulated tenants remained in dire disrepair. "We did everything to fight the plan," said Joan Ann Charles, the lawyer for the tenants, "but we were told by the Attorney General's office that the sponsor's only duty was to disclose the defects in his offering plan; they had no power to make him fix the defects."

Retaining 75 percent of the units, Mr. Ziegelman controlled the board. "He set up this dummy board," said Mr. McMichael. "Most of us were not clear on the laws, the rules on running a co-op. He was like a ghost. We tried to get him to call meetings. You could never reach him by phone."

Two months after conversion, Mr. Ziegelman stopped paying maintenance on his 62 apartments. But it would be a year before the shareholders found out. Robert Hartman, a lawyer hired to represent the shareholders after Mr. Ziegelman defaulted, said a company controlled by the sponsor was the building's managing agent. "If an independent agent had been there, perhaps some alarm bells would have gone off," Mr. Hartman said.

When Mr. Ziegelman sold someone an apartment "he would say, 'You can go to the bank or we will do the end loan for you,' " Mr. McMichael said. "Nothing wrong with that; it's American enterprise." Then Mr. Ziegelman would sell the loan to a bank.

"From those who got their own loan, he got the $60,000, $100,000, whatever the price of the apartment, right there," Mr. McMichael said. But when Mr. Ziegelman financed the end loan, he would receive a small down payment from the buyer and a promissory note for the balance of the loan. Then, when he sold those end loans to a bank, even at a discount, "he still made another $20,000, $30,000," Mr. McMichael said. "All he was interested in was getting the money and running."

Mr. Ziegelman sees it differently. "All I know is I lost all my money there," he said in a brief telephone interview. "When the trouble arose, the buyers defaulted because of the problems in the building. When the rents collected were less than the maintenance and the whole thing collapsed, that's the problem. No one accused me of doing anything that was improper. It was like a chain reaction."

In March 1992, with Freddy Mac about to foreclose and auction off the property, the co-op filed for bankruptcy. Mr. Ziegelman also defaulted on the two neighboring buildings.

Most of the following year was spent searching for a "white knight" -- someone willing to invest in the unsold apartments while negotiations continued with Freddy Mac to restructure the mortgage. A parallel plan, Mr. Hartman said, was to transfer the shareholders from 101 Lincoln Road and those from one or both of the neighboring co-ops into one building, creating at least one viable co-op and two rentals. Neither plan materialized.

And in early 1993, Freddy Mac had the bankruptcy stay on foreclosure lifted, with ownership reverting to the F.D.I.C., and the building eventually deconverting into a rental.

"It was so much stress," said Mr. McMichael. "I was a newlywed. We just didn't know whether we were going to have a home from one week to the next. I was 21 years old, looking at $60,000 of debt. In the end, I still owe $60,000 for nothing.

"I'm trying to build a new life and constantly looking over my shoulder."

The injustice is real and unnecessary, said Mr. Lappin of the Community Preservation Corporation. "It's inherently unfair for the individual," he said. "The community loses good and affordable home ownership. And it's incumbent on all of us -- government and the banking community -- to change all of that, because there are solid solutions to avert such a bad outcome."